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The Cost of Gold and the Economy

10 October 2012 2 Comments

Throughout history, gold has been widely used as currency, and it still has palpable economic connections to this day. In fact, until relatively recently, the United States relied on the gold standard, which guaranteed that all paper money printed was backed up by its value in gold. The gold standard is no longer in use around the world—the U.S. dropped it in the 1970s—but some developed countries maintain extensive gold reserves. (Some politicians are currently advocating for a return to the gold standard in the United States, but this has been met with heated debate.) Gold was also traditionally used as the global reserve currency, which means that central banks used it for international debt repayment. The U.S. dollar now holds this honor, but gold is still considered an extremely valuable currency and a major indicator of economic health in this country and around the world.

Gold prices are inextricably linked to economic health: the value of the U.S. dollar primarily determines the current price of gold. Prices inflate and deflate due to a multitude of factors, and paper money is worth less when more of it is in circulation. When the value of the U.S. dollar decreases, the price of gold increases. The reverse is also true.

Some people consider the relationship between the U.S. dollar and the price of gold to be a chicken-or-egg kind of question. However, the fact is that the price of gold is high when the economy is in trouble. Whenever there is a recession, investors turn to gold, which tends to hold its value over time. Gold has historically been a steady investment during troubled economic times—including the past several years, which is why the price of gold remains high. When gold prices are low, it usually means that the economy is healthy because investors are not worried about recessions or inflation. Instead, they are tied up in other investment options, like stocks and bonds.

Gold also affects the global economy, particularly those countries that import or export it. Countries that export gold have increased exports when the price of gold is high, and their currencies are strengthened. On the other hand, countries that import gold often end up with weaker currency when the price of gold is high. In addition, whenever central banks (like the Federal Reserve in this country) purchase gold, it can result in inflation by affecting the national currency’s supply and demand, which impacts the global economy as well.

In addition, the cost of gold can affect banks and financial lending institutions in this country. In the early 20th century, people didn’t trust banks and began hoarding gold at rather alarming rates. The federal government actually had to ban gold hoarding in order to repair the nation’s banking system. No one recommends hoarding gold in this day and age, but is it a good idea to invest in gold? Some financial experts recommend gold as part of a diversified portfolio that includes other commodities and assets, as gold’s price will increase when paper investments (such as stocks and bonds) decline in value. And while gold can act as a short term hedge against inflation, young investors should note that it is not useful for generating a great deal of money over a long period of time. In fact, gold may be most useful as insurance for potential catastrophic financial events. (However, other commodities could likely serve the same purpose in such a scenario as well.) Nonetheless, gold is likely to continue to play an integral role in our national and global economies for years to come. As such, it may be worth considering as a potential investment.

Garfield Refining is a Philadelphia based precious metal refinery offering nation-wide service. This 120 year old refinery buys and refines gold, silver, platinum, and palladium and services both B2B and B2C markets. For live gold prices check out Garfield Refining on twitter.

2 Comments »

  • Aram Durphy said:

    Gold hasn't fared very well over time, Deutsche Bank recently published its annual Long-Term Asset Return Study, and stocks were by far the winner:

    Asset Average Annual Real Return, 1838-2012
    Stocks 6.49%
    Treasuries 2.77%
    Corporate Bonds 2.72%*
    Gold 0.35%

  • Brad C. said:

    I agree, gold is an important component of a smart portfolio; it's better looked at as an insurance policy. It's definitely not a way to make a quick buck at today's prices.